Acc 690 Partnership in Businss

ACC 690

Milestone 1

Jordan Brown

February 3, 2017

When going into business it is important to consider many factors. One very important first steps deciding what form of business to start. There are many options from sole proprietorship to corporations. Creating a partnership is one very popular option. Key information to know when deciding whether or not to enter into a partnership includes partnership formation, how profits and/or losses are split and what happens if the partnership has to dissolve.

        The first step in considering a partnership is how it is formed. Generally, a partnership is a business arrangement between two or more parties. Although it can be established orally or in writing, it is recommended that a partnership be formed in writing. This is called articles of partnership and they outline the partners’ duties and responsibilities. Partnership require financial statements just like any other business. The main difference between financial statements produced by a partnership and those produced by a corporation is a partnership has capital accounts. On the balance sheet of a corporation the equity section “has two main sections: contributed capital and retained earnings” (Merritt). The equity section on a partnership’s balance sheet includes a capital account for each partner. “Individual capital accounts are accumulated for every partner or class of partners” (Hoyle).

When forming a partnership the partners can contribute cash, assets, liabilities and intangible contributions. The simplest method is when partners contribute only cash to begin the partnership.

*To record cash contributed to start new partnership

This is the simplest method of beginning a partnership. However, the formation of partnerships often involves the investment of noncash assets “such as inventory, land, equipment, or a building” (Hoyle) in the partnership. When noncash assets are transferred to begin the partnership they are transferred at fair value. For example, if Company X contributed $80,000 in cash their capital account would be $80,000. If Company Y contributed inventory valued at $12,000, land valued at $15,000 and a building valued at $50,000 with a mortgage of $26,000 their capital account would be $51,000 (12,000+15,000+50,000-26,000).

*To record properties contributed to start partnership. Assets and liabilities are recorded at fair value.

        Sometimes when a partnership is established intangible contributions are made. One or more of the partners may bring expertise to the business or an existing client base. Because such intangible attributes can be valuable to a business “formal accounting recognition of such special contributions may be appropriately included as a provision of any partnership agreement” (Hoyle). There are two ways to account for the recognition of intangible assets: the goodwill method and the bonus method.

        The bonus method assumes that the intangible contribution “does not constitute a recordable partnership asset with a measurable cost” (Hoyle). Under this method, total partnership capital is determined by assets that are physically transferred to the partnership. Intangible contributions are used in a separate process to establish the specifics of each partners capital account balance. Assume Company X and Company Y agree to set up the partnership with equal capital balances. Company X contributes $30,000 in cash and Company Y contributes $10,000 in cash. Company Y also brings an established client base to the partnership. According to the bonus method each capital account will have $20,000 in it. Company Y received a capital bonus of $10,000 in recognition of the clients it has brought to the business.

*To record contribution with bonus to Company Y because of clients brought to partnership

        The goodwill method assumes that “an implied value can be calculated mathematically and recorded for any intangible contribution made by a partner. In the precious example Company Y invested $20,000 less cash than Company X. Under the goodwill method Company Y’s client list has an apparent value of $20,000.

*To record cash contribution with goodwill attributed to Company Y because of clients brought to partnership

Both methods create equal capital accounts for both partners. However, partnership goodwill should be viewed with  professional skepticism since it has no historical cost. Under the goodwill method “the business recognizes an asset even though no funds have been spent” (Hoyle).

        Once a partnership has been established, it is important to know how profits and losses can be split. There are any number of ways to split profits and losses. Therefore it is extremely important that the division of profits and losses is set out in the articles of partnership. If it is not spelled out, “State partnership law normally holds that all partners receive an equal allocation of any income or loss earned by the business” (Hoyle). Profits and losses can be split equally between partners, they can be divided differently depending on capital contributions made, expertise contributed or how much day to day management each partner does.

        Assume that Company X, Company Y and Company Z enter into a partnership by investing $90,000, $50,000 and $45,000 respectively. The articles of partnership state that Company Z will receive 40% of all profits because they will be overseeing the day to day management of the partnership. The other two will split the remaining 60% equally. The agreement also states that each company can withdraw $15,000 annually from the business. At the year end the partnership reports $80,000 in profits.

*To close out drawing accounts